Attention investors heaving a sigh of relief that the corporate earnings recession appears to have ended. A new twister is about to be unleashed.

This tempest is the result of dramatically lower funding of corporate pension plans following the stock market’s plunge. After using overfunding of the plans to enhance profits, companies have lost their earnings catalyst and are racking up billions in liabilities.

“This is going to be an extremely hot topic,” said Howard Silverblatt, editor of quantitative services at Standard & Poor’s. “The fat is about gone. These companies have to start putting in hard cash.”

“I’m anticipating that the data for the end of 2002 are going to be atrocious,” said actuary Adrien LaBombarde of Milliman USA, a pension consulting firm.

Compounding two years of big losses is the threat of long-term weakness in equities and auditors who, post-Enron, are more likely to question projected returns for pension plans, LaBombarde added.

Companies with hefty pension plans tend to be old economy stalwarts rather than young tech firms – materials giants such as DuPont, industrials like Boeing and telecoms, including Verizon. Others expected to see huge hits include SBC Communications, ExxonMobil, Lucent and Delphi Automotive.

Merrill, in a research report by analysts Adrian Redlich and Rebecca Skilbeck, warned that analysts likely will downgrade earnings estimates for 2003 because of pension liabilities and said some companies could be headed for a cash crunch.

“You’re talking about enormous amounts of money that have to be paid,” said Silverblatt. “That cash has to come from somewhere.”

Equally disturbing is the impact on companies’ loan covenants with banks, noted Robert Willens, a tax and accounting analyst at Lehman Brothers. Some companies may violate loan terms and be forced back to the bargaining table with lenders, he said.

Such was the case with Delta Air recently, when it predicted costs of $800 million in the fourth quarter, partly to reflect higher pension fund obligations. The extra costs put it in noncompliance with credit agreements.

Earnings of S&P 500 companies would be 10 percent lower for the year ended June 30 if pension gains are subtracted, Silverblatt estimated.

According to Merrill, of the 346 S&P 500 companies offering plans, 98 percent are expected to be underfunded by year-end – by a total of $640 billion. Its calculations are based on an 18 percent decline in stocks and 10 percent rise in bond yields, with plan holdings generally 60 percent stocks and 40 percent bonds.

Pension Problems

As companies have to make up for losses in their pension plans, it will eat into earnings. Here’s how much it could hurt: